Friday, June 09, 2006

Sold Short!

Short selling may have turned the ugly side of its face toward the light in the Vonage IPO. The financial press is reporting that the NYSE is investigating what role, if any, short sellers may have played in the price decline in the newly issued shares of Vonage Corporation (VG: NYSE). The NYSE is concerned that some traders may have engaged in “naked short selling” of Vonage, that is, a sale without access to shares that could be provided to the buyer. When traders do not provide shares to back up their sales, they can effectively sell the same shares over and over. It leaves the barn door wide open to capricious and manipulative trading activities.

Although the lead underwriters claim otherwise, the Vonage offering was apparently a weak one, that is, without sufficient institutional interest to take up the shares offered. Nonetheless, it is still a bit suspicious that the stock declined 13% on the first day of trading - the same day over 5.0 million shares were sold short or about 15% of the offering. Since then Jeffrey Citron and his compatriots at Vonage have had to stand by and watch the price of their newly issued shares fall by more than 30% from the offering price even before the ink dried on the certificates.

It is not that the NYSE cares a whit about the misery of Vonage executives. What really rankles regulators is that they just went through a rule tightening exercise aimed at eliminating naked short selling. New rules just took effect in January 2005, requiring exchanges to report stocks that routinely subject to failed deliveries of stock to cover short sales.

The regulations were not the first effort of the exchanges or the SEC to rein in abusive traders. Manual Asensio was barred from the industry, at least for a while, for his short selling activities. He is both vilified as a crook and worshipped as a visionary. His book, Sold Short: Uncovering Deception in the Markets, which he wrote with the help of Jack Barth, both extols his methods and tweaks authorities. While the establishment investment community might be as stuffy and myopic as he suggests, his numerous examples of small overly promoted stocks reveals the shallowness of his strategies as not much more than “reverse hype.” Some reviewers say the book is entertaining, but I found the attempts at humor somewhat juvenile.

A more serious, but perhaps more useful “how-to-book,” The Art of Short Selling, was authored by Kathryn Staley. She offers some fairly solid and practical advice on how to discover and capitalize on the legitimate short sale opportunity. Staley looks at overbought stocks, i.e. those priced too high given shaky balance sheets or deteriorating fundamentals.

Of course, no short seller’s library is complete without William O’Neil’s How to Make Money Selling Stocks Short. The title tells it all and O’Neil’s success as a trader backs up his practical advice, which is as helpful for the investor with "long" position as it is for those with short-selling strategies.

No comments: